Business context and reporting period
Arbor Realty Trust, Inc. filed this unaudited Form 10-Q for the three months ended March 31, 2017. The REIT operates a Structured Business investing in commercial and multifamily real estate loans and related assets, and an Agency Business that originates, sells and services multifamily loans through GSE, HUD and other programs. The Agency Business was acquired in July 2016, so the prior-year quarter is not fully comparable.
Financial performance and position
| Metric | Q1 2017 | Prior comparable period / balance |
|---|---|---|
| Interest income / expense | $33.5m / $19.4m | $25.8m / $12.7m |
| Net interest income | $14.1m | $13.1m, up 8% |
| Net income | $23.9m | $3.0m |
| Net income attributable to common stockholders; diluted EPS | $15.6m; $0.30 | $1.1m; $0.02 |
| FFO / AFFO, diluted per share (non-GAAP) | $23.6m / $24.7m; $0.32 / $0.33 | $1.5m / $6.9m; $0.03 / $0.13 |
| Operating / investing / financing cash flow | $73.2m / $44.4m / $(151.4)m | $3.8m / $(113.9)m / $66.5m |
| Cash and restricted cash | $104.8m / $115.3m | $138.6m / $29.3m at Dec. 31, 2016 |
| Total assets / total equity | $2.91bn / $759.7m | $2.97bn / $747.0m at Dec. 31, 2016 |
| Debt obligations, carrying value | $1.96bn | $2.02bn at Dec. 31, 2016 |
Agency Business activity generated $19.2m of net gains on sales and fee-based services, $20.0m of MSR income and $4.8m of net servicing revenue. Agency loan sales were $1.36bn, with a 1.40% sales margin; the servicing portfolio grew to $14.47bn. Structured portfolio loans and investments were $1.73bn unpaid principal balance, with a 5.81% weighted average current pay rate. The Structured Business reported a 6.39% average yield on core interest-earning assets and a 4.51% average funding cost.
Quarter-end debt included $855.1m of credit facilities and repurchase agreements, $729.2m of CLOs, $94.7m of senior unsecured notes, $94.2m of convertible notes, $139.1m of junior subordinated notes and $50.0m of related-party financing. Management reported compliance with debt covenants. Approximately $725.9m of debt maturities were scheduled for the remainder of 2017. The company also reported $555.5m of available capacity under listed debt facilities; availability is subject to facility terms and collateral requirements.
Material changes versus the prior period
- Net income attributable to common stockholders rose to $15.6m from $1.1m. Results benefited from the acquired Agency Business, including loan-sale and servicing-related income, and a $7.1m gain from repurchasing junior subordinated notes at a discount. Comparisons are affected by the Agency Business acquisition and its absence from Q1 2016 results.
- Interest expense increased 52% overall, faster than interest income’s 30% increase; net interest income nevertheless rose 8%. For the Structured Business alone, management attributed higher interest expense to increased average debt balances and funding costs.
- Cash and cash equivalents fell $33.8m from year-end, while restricted cash increased $86.0m, principally reflecting CLO cash and Agency collateral requirements. Operating cash flow included timing-related net inflows from Agency loan sales exceeding originations.
- Structured loans and investments declined from $1.79bn to $1.73bn unpaid principal balance as payoffs exceeded originations. Loans held for sale declined from $673.4m to $573.2m.
- The common dividend was $0.17 per share for Q1; in May, the board declared $0.18 per share, the third increase in four quarters. A $13.8m additional convertible-note issuance brought principal outstanding to $100m. The company also repurchased $20.9m face amount of junior notes.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said existing funding sources were expected to meet short- and long-term liquidity needs, while noting that longer-term requirements depend on continued access to debt and equity financing.
- In April 2017, the company completed CLO VII, issuing $279m of investment-grade notes against a portfolio expanded to $360m of loan obligations; it retained an $81m residual interest. The notes’ initial weighted average rate was 1.99% plus one-month LIBOR.
- Management described commercial real estate markets as improving but highlighted uncertainty, signs of stabilizing multifamily rent growth, possible property-value declines, and potential effects of further interest-rate increases. GSE production limits or reduced GSE originations could also weigh on results. Management said recent rate increases had not significantly affected results to date.
- Credit and collateral risks include seven impaired loans with $186.6m aggregate carrying value before $83.0m of reserves, and higher-risk loans of $147.9m before reserves. Six land-development loans totaling $120.9m mature in September 2017; interest accrual was suspended in 2008 and cumulative reserves were $49.1m. The company reported three non-performing loans with $23.2m carrying value, substantially reserved.
- Fannie Mae DUS loss-sharing exposure is material: the maximum quantifiable guarantee liability was $2.14bn, which the filing says is not representative of expected loss. The company had $32.2m of loss-sharing reserves and expected to fund $25.6m of additional restricted liquidity over 48 months, assuming no portfolio changes.
- The hotel property incurred a further $1.2m impairment; its Q1 occupancy was approximately 55%, versus 66% a year earlier. An office building became vacant after its tenant’s lease expired in April 2017.
- An Extended Stay-related lawsuit seeks approximately $139m in aggregate from numerous defendants, including company affiliates. The company is defending the claims, made no accrual because it considered a loss not probable and not reasonably estimable, and the court had reserved decision on a motion to dismiss.
- Governance and related-party matters merit attention: the company is externally managed, reported $4.0m of quarterly management fees, and disclosed numerous loans and transactions involving executives, the Manager or affiliates. Its Manager and associated OP Units represent substantial voting interests. The filing also identifies REIT qualification and capital-market access as risks.
Important facts for investors to verify
- How much of reported earnings and AFFO reflects recurring spread and servicing economics versus MSR valuation, note-extinguishment gains, and other nonrecurring or noncash items.
- The schedule and refinancing plan for the $725.9m of debt maturities due in the remainder of 2017, including the effect of collateral needs and facility renewals.
- Performance, collateral values, maturity extensions and reserve adequacy for impaired and higher-risk loans, especially the land-development exposures.
- Actual and potential Fannie Mae DUS losses, restricted-liquidity requirements, and any change in GSE or other agency rules or origination limits.
- The assumptions underlying MSR valuations and the effect of prepayments and interest-rate changes; management estimated a 100-basis-point discount-rate increase would reduce MSR fair value by about $8.6m.
- Progress and potential outcomes in the Extended Stay litigation, and the governance implications of external management and related-party lending and transactions.
- Whether the May 2017 dividend increase is supported by recurring distributable cash generation; GAAP cash flows and the company’s non-GAAP FFO/AFFO are not interchangeable.